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Chipmaker Sipex Raises More Red Flags

The company attributes a wider loss to a technicality, but the change only raises more questions.

Shares of analog chipmaker



lost ground Tuesday after the company, which has come under fire for cozying up to its top customer, said that a change in accounting had rendered its third-quarter loss more than 50% bigger than it initially reported.

In a separate revision, the company slightly increased its quarterly loss after admitting it had shipped less product than originally assumed.

Sipex stock was down 21 cents, or 2.3%, to $8.75 Tuesday afternoon.

Late Monday, Sipex said that after consulting with independent auditors, it had decided to modify the accounting treatment of a convertible promissory note it issued in June 2003 to Alonim.

Alonim is both the lead investor in Sipex and the parent company of Sipex's primary customer, Future Electronics, a private Canadian distributor. As

reported last week, that highly unusual relationship has come under fire from corporate governance experts and analysts.

"While we believe that Sipex remains realistic in its operational goals, we remain concerned that Future Electronics' relationship as both a stakeholder (about 35% equity stake) as well as a major customer could induce significant volatility in Sipex's financials," said Deutsche Bank analyst Ross Seymore in a note Tuesday. He has a sell rating on the stock; his firm has done investment banking for Sipex.

Sipex's former accounting firm, KPMG, quit last June after highlighting "material weaknesses" at the company during its 2002 audit. Sipex launched a campaign to clean up its accounting practices starting last spring, prior to KPMG's resignation.

The change in accounting announced Monday affects the third-quarter results reported by Sipex on Oct. 30. At the time, some analysts cast Sipex's results as evidence of an ongoing turnaround at the company. But Monday's revision has the effect of dramatically increasing the net loss for the period, while reducing sales. The treatment didn't affect the company's operational results or cash flow.

Instead of a $2.1 million loss equivalent to 7 cents per share, Sipex now says it should have reported a loss of $3.3 million, or 12 cents a share.

Also, instead of the previously reported $16.5 million in sales, revenue amounted to $15.2 million. The change means Sipex sales actually fell 8.4% from the prior year's $16.6 million. When it initially reported earnings for the period, Sipex said sales were about flat with last year's levels.

According to Sipex, the restated results reflect a noncash reduction of $1.2 million to both sales and earnings. The changes relate to a $10.6 million convertible loan that Sipex sold to Alonim last summer. Under the terms of the deal, Alonim can exchange the note for 3 million shares of Sipex common stock, provided that Future Electronics sells enough Sipex product over a period of several years.

Sipex said the revised sales and earnings numbers reflect "the fair value of the conversion rights attributed to the proportion of the annual sales target achieved in the third quarter."

But Wall Street reacted with confusion to the latest news. "If the red flag was already up, this raises it a little higher," said one analyst, who declined to be named.

Asked to explain why Sipex made the changes, CFO Phil Kagel cast it as the result of a technical accounting issue. "It's just analyzing the contract in light of the EITF01-1," referring to an accounting treatment the

Securities and Exchange Commission

uses for certain types of convertible notes, Kagel said. The company initially had determined that the deal with Alonim didn't require the treatment, but recently changed its mind.

"It's really important to keep in mind it's a noncash charge," he added.

CEO Walid Maghribi said in a statement that Sipex wants "to change the agreement to reduce or eliminate the ongoing accounting effects while attempting to preserve the features with the positive impact on sales." But, he added, "We are extremely pleased with our ongoing business relationship with Future Electronics."

Separately, in the same release announcing the $1.2 million noncash reduction in sales and earnings, Sipex said that following a "postclose review," it had decided to reduce net sales by $85,000 and increase its net loss by $39,000.

Kagel said the changes were made because certain shipments did not take place in the quarter, as had originally been assumed. "They're a pretty insignificant number," he said.

Whether the revisions are "insignificant" or not will be up for investors to decide. Either way, the news highlights the downside of Sipex's close embrace of Future Electronics, creating exactly the kind of financial tangle that critics had warned would result from the union.